Members of the Morrison & Foerster Technology Transactions group offer practical guidance on how to manage and mitigate risk as the COVID-19 pandemic interrupts operations and impacts performance. The first installment in this two-part series explores using the force majeure clause in adjusting performance expectations.
When disaster strikes, technology supply chains and services are disrupted. The novel coronavirus (COVID-19) pandemic continues to severely disrupt supply chains and business operations around the world. The impact has reverberated across the technology sector, as it has across the economy as a whole. Technology vendors may find it difficult to fulfill customer commitments due to constraints on their own operations as well as those of their suppliers. And companies that are reliant on supply of technology products or services are experiencing or anticipating delays and outright failures of suppliers and service providers to perform.
Both buyers and suppliers of technology products and services can mitigate these risks in supply, sourcing and services agreements. This article compares the law in the U.S., U.K. and Germany, reviewing force majeure principles, key related provisions common in technology-related product and services agreements and legal doctrines relating to excused performance across these jurisdictions and explores how they might apply to suppliers and buyers of technology products and services that are assessing and looking to mitigate risk in light of the current pandemic.
Why Force Majeure?
Generally, courts in the U.S. and U.K. are reticent to excuse performance in the absence of a contractual agreement to do so (this is not necessarily the case in Germany or China); this is as true for technology transactions as other types of contracts. A force majeure clause can bring clarity to when performance will be excused, as well as what other rights or remedies a customer might have if a vendor seeks to be excused from performance due to a force majeure event. If a contract is silent on force majeure, courts will decide whether to excuse a party’s performance based on applicable common law or statutes (discussed in more depth below).
The aim of a force majeure clause is to excuse one or both parties (temporarily or permanently) from performance of the contract following the occurrence of certain events. The central principle is that a party to an agreement ought to be excused from (or entitled to suspend) performance of its obligations in whole or part upon the occurrence of unexpected events or circumstances outside that party’s control. Contracts may also specify a right of termination if the force majeure circumstances endure (in order to avoid parties having to keep resources available over an extended period of time).
The typical key elements of a force majeure clause are:
- Defining what constitutes force majeure;
- Identifying the process by which the protection of force majeure should be claimed;
- Defining the effect of force majeure on performance;
- Specifying the effect of force majeure on payment; and
- Creating a link to termination or adjustment of the contract.
Defining the Force Majeure Events
Under U.K. and U.S. law, force majeure has no recognized meaning as a term of art. It should only be used in agreements when it is properly defined (in the U.K., even finding a clause that is not explicit as to scope void for uncertainty). Under German law, several statutory provisions use the term “force majeure” for establishing exceptions to liability, but these provisions do not define this term. German courts define force majeure rather narrowly as an extraordinary, external event that was not foreseeable, cannot be averted even by the utmost care that could reasonably be expected and cannot be attributed to either party’s business or personal sphere (i.e., is not the realization of a risk attributable to its business operations or personal situation as such (see for example, BGH judgment of May 16, 2017, X ZR 142/15)). Under the PRC law, “force majeure” is defined as a circumstance that is objectively unforeseeable, unavoidable and insurmountable.
Commercial agreements in the U.S. usually define force majeure events based on the parties’ negotiation. A standard clause may include: acts of God; flood, earthquake, storm, natural disaster and adverse or extreme weather; epidemic and pandemic; war or armed conflict; sanctions or embargoes; nuclear, chemical or biological contamination; fire, explosion or malicious damage; terrorist attack, riot or civil commotion; and governmental order or direction. In commercial agreements governed by German law, force majeure clauses are still not as common as in the U.S. or the U.K., which is probably the result of many parties relying on the specific rules German statutory law provides for an impossibility of, or delay in, performance.
When agreements governed under German law address force majeure (in particular to include cases or consequences not provided under statutory law), the clauses either tend to be similar to the U.S. and U.K. standard clauses or apply a variation of the definition used by the German courts, adding some examples.
With respect to commercial agreements governed by the PRC law, some of them contain force majeure clauses similar to U.S. and U.K. standard clauses, while others may remain totally silent on the force majeure issue or only contain general force majeure language, citing the force majeure doctrine under the PRC Contract Law, without specifying the events falling within the scope of force majeure and the specific consequences of force majeure. If commercial agreements do not contain force majeure clauses or do not specify the force majeure events and consequences, the parties may have to seek remedies by invoking the force majeure doctrine under the PRC Contract law (see below).
Courts in most jurisdictions, including the U.S., U.K., Germany and China, tend to narrowly interpret force majeure clauses. As such, unless events such as pandemics and quarantines are specifically identified as force majeure events, parties should not assume that a court will interpret catch-all language such as “acts of God” to include risks not listed that the parties were aware at the time of negotiations or entering into new contracts after the specified risk becomes widely known and foreseeable (e.g., contracts negotiated or entered into after the situation with COVID-19 began).
Courts adopted a narrow interpretation of force majeure clauses in a number of U.S. cases involving the supply or procurement of technology-related products and services. In Free Range Content, Inc. v. Google Inc., No. 14-CV-02329-BLF, 2016 WL 2902332, at 6 (N.D. Cal. May 13, 2016), an activity for an online advertising content program was not excused as a force majeure because it was not specifically identified in the agreement as a qualifying force majeure event, and in Kyocera Corp. v. Hemlock Semiconductor, LLC, 313 Mich. App. 437, 886 N.W.2d 445 (2015), a force majeure clause in a take-or-pay contract between a solar panel manufacturer and polysilicon producer was narrowly interpreted, such that the actions of a foreign government that allegedly depressed the solar panel market prices did not qualify as a force majeure event. The court explained that since it was not specifically identified, it did not fall under any of the general categories such as “acts of God” or “acts of the government or the public enemy.
Typically, a customer or recipient of goods or services will prefer a tightly defined clause, listing only certain events, acts or omissions and excluding all other possibilities. Service providers will typically prefer a broader listing together with a general sweep up (“all acts, events or circumstances beyond the reasonable control of the party concerned”). A broad sweep up is usual, because it’s not realistic to expect to be able to predict all conceivable force majeure events (which, by definition, are supposed to be unpredictable).
The burden of proof [in the U.S. and U.K.] is on the party seeking to rely on the force majeure clause, who must prove that the event falls within the clause and that non-performance was due to the event. In the current COVID-19 situation, a party may feel that it’s self-evident that force majeure applies — but, contractually, it still usually needs to be invoked by notice. Time limits would normally apply to give notice. And there is a clear line of English law cases, which require that parties comply strictly with the contract notice requirements (at the risk of not being protected if they fail to do so) — so parties ought to check the Notices provision as well as the force majeure section. This principle also applies in the U.S., and the party seeking to rely on the force majeure clause has the burden of proof.
Some contracts may impose a direct link between strict adherence to the claim or notification process and the right to protection (i.e., failure to give prompt notice deprives the affected party of the right to claim the benefit of force majeure). That’s negotiable, but whatever the notice procedures in the contract are, they should be followed. If notice is required, it does not matter if the whole world knows about the happening of the force majeure event, as it is the service of the notice that triggers the protection.
English and U.S. courts will imply a duty to mitigate an event within a defined set of force majeure circumstances — including, we must assume, events stemming from COVID-19. If an affected party ceases its efforts to mitigate, a court may conclude that the performance obligations should re-commence. These principles also apply in the U.S., and U.S. courts generally imply a duty of the contracting parties to take reasonable measures to mitigate losses.
A force majeure clause ought to specify the consequences of the force majeure event. Usually, that would be the postponement of all affected performance requirements until the alleviation of the force majeure event (i.e., a right of suspension of performance). But the contract may well also specify that all other services should be performed as usual.
The clause will typically provide that the force majeure event does one or more of the following — but the exact consequences of claiming force majeure ought to be checked against the contract language:
- Excuses the affected party from performance of certain obligations under the contract;
- Allows an extended period to perform the affected obligations;
- Allows the affected party or the other party the right to terminate the contract; and
- Exempts the affected party from liability for any delays (e.g., no LDs or service credits) or additional expense incurred.
Some contracts will contain prioritization requirements (e.g., to require the provider to commit to devote at least equal resources to restoration of the customer’s service as to its other clients or to commit not to re-assign key personnel to other roles pending the restoration of service). Again, these requirements should be complied with so far as possible — although it may require the Judgement of Solomon to prioritize between key customers where resources are massively constrained by COVID-19 restrictions.
Effect on Payment
Customers would normally expect to reduce payments pro rata for services not delivered due to force majeure, but if one force majeure option is to source services elsewhere, the contract may specify that the provider is liable for the increased cost of procuring such services over and above what otherwise would have been paid to the service provider for so long as the delay in performance continues.
Link to Termination
If service is disrupted or suspended for a certain period of time (which would depend on the nature and materiality of the service), either one or both parties may have the right to terminate the contract (in whole or in part). A customer may seek to be the sole party with the right to exercise such option.
The provider may wish the contract to specify intermediate steps short of termination (e.g., a right to procure, or direct the provider to procure, services from an alternate source or to remove the affected services from the scope of the agreement and equitably reduce the charges to reflect the terminated services). A party also might have termination or suspension rights independent of force majeure provisions in the event of unexpected or disruptive occurrences, such as is the case with COVID-19. For example, the occurrence of certain events (or more likely, consequences of the occurrence) could trigger termination events that had been expressly written into the contract, such as termination rights following the cessation or suspension of operations by a party. This is particularly relevant in financing agreements where events of default are often drafted broadly and designed to take effect if there is a significant impact to the borrowers’ ability to repay any financing.
Further, certain contracts may obtain a clause providing for termination or suspension in the event of a “material adverse change.” These “MAC” clauses are designed as a “sweep up” to cover termination events (or events of default) that are not expressly included in the agreement. In some circumstances, depending on the scope and looseness of the drafting of the MAC clause, this introduces a degree of uncertainty as to whether the clause has been properly triggered, and this can leave any enforcing party in the unfavorable situation of having breached the contract itself if it is later found that the conditions for a MAC have not been met.
While the interpretation of these clauses is specific to the facts of each situation and the wording of each clause, helpful guidance was provided by the English courts in the case of Grupo Hotelero Urvasco SA v Carey Value Added SL & anor  EWHC 1039 (Comm):
- a change will only be material if it affects a company’s ability to perform its obligations under the relevant agreement;
- a party cannot trigger a MAC clause in respect of circumstances of which it was aware at the outset; and
- in order to be material, a change must not be merely temporary.
Link to Business Continuity and Disaster Recovery
Many companies faced with a crisis will initially focus on transitioning their own workforce in accordance with their own or contractually required business continuity and disaster recovery plans. Reviewing these plans is a critical first step for those companies. For companies that have contracted with customers to perform in accordance with negotiated or pre-set business continuity and disaster recovery plans, not only is this step prudent, but it is essential to avoiding potentially substantial liability for breaching these commitments. Typically, a force majeure clause should not affect the provider’s specific obligation to provide business continuity and disaster recovery services.
If a company has sourced services from third parties, whether they be data center operations and management, technology development, call-center services, finance and accounting services or any other IT or business process services, reviewing the business continuity and disaster recovery commitments under these agreements will be critical in assessing next steps with your services vendors.
Often these plans depend on availability of third-party service providers and facilities in geographies other than the company’s own. One of the unique challenges of the COVID-19 pandemic is its global nature and the fact that it is impacting the ability of companies to conduct normal operations around the world. Even the most robust business continuity and disaster recovery plans likely won’t mitigate risk adequately under these circumstances. And, depending on how your contracts are structured, vendors may be excused from performance if non-performance results from circumstances beyond their reasonable control. When this circumstance arises, companies may need to look to non-contractual approaches to mitigating risk. By engaging with customers and putting remediation plans in place early, companies can reduce risk. At the same time, when companies notify customers of potential difficulties in performing, particularly with regard to the supply of goods, they may be providing those customers a way out of their own contractual commitments.
Morrison & Foerster associates Richard Jerman and Jackie Li and senior legal consultant also Angela Shen contributed to the writing this article.